Source: PaxForex Premium Analytics Portal, Fundamental Insight

IBM has undergone a distinct transformation since Arvind Krishna became CEO in April last year. Thanks to the company's move toward cloud computing and the spin-off of a key business, IBM is likely to become a different technology company over time. Consequently, the extent to which IBM can remake itself as a cloud company will likely determine how much its stock rises over the next few years.

For most of the last decade, IBM has struggled as a company that helped companies design and manage IT systems and businesses. As the technology industry has evolved, its stock peaked in 2013 and has steadily declined amid slowing growth. To bring the company in line with the current technology environment, IBM spent $34 billion to buy cloud solutions giant Red Hat in 2019.

Krishna, who at the time was head of IBM's cloud and cognitive software division, spearheaded the acquisition. Red Hat brought IBM into the hybrid cloud market, which it describes as a "$1 trillion market opportunity." With a hybrid cloud system, public and private clouds work together easily and securely, something most cloud systems need. 

Since becoming CEO last April, Krishna has acquired many other cloud businesses and started developing an infrastructure services business, now called NewCo.

Although NewCo claims $60 billion in debt, revenues are down nearly 6 percent in 2020 under Global Technology Services (GTS), the division in which NewCo currently resides.

NewCo represents $19 billion of the company's $73.6 billion in revenue, only slightly below the $23.4 billion the cloud and cognitive software division generated in 2020. That means that once the allocation is complete, cloud and cognitive software will be IBM's largest division. However, IBM will also design and operate IT systems through Business Services, build supercomputers within its systems division, and offer payment options through global financing.

Krishna estimates that IBM's total revenue will grow at mid-single-digit levels in 2022 and beyond, after the allocation, which will likely be driven by the hybrid cloud. Cloud revenue is up 19% in 2020, slightly above the compound annual growth rate (CAGR) of 15% projected by Grand View Research for the global cloud computing market through 2027. The gap between this growth rate and IBM's future projections suggests that the company may need more asset sales to get rid of inefficient assets.

Also, IBM still has some catching up to do as it is lagging far behind cloud competitors such as Amazon AWS and Microsoft Azure. According to Gartner, IBM has less than 2 percent of the infrastructure-as-a-service market, compared with 48 percent for Amazon and 16 percent for Microsoft.

Still, with its Red Hat assets, IBM believes it can become the "default choice" for hybrid cloud architecture. This will come from its open-source Linux operating system; containers that pack applications into which they can easily run on a wide variety of systems; and Kubernetes, a system for deploying containerized applications.

Hybrid clouds can also struggle with interoperability and complexity. Both AWS and Azure claim compatibility with different types of computers and operating systems. However, the default architecture proposed by IBM can make hybrid clouds more efficient. This, along with decades of experience in services and business relationships, can help create a competitive advantage for IBM. New partnerships with Lumen Technologies, Delta Air Lines, Humana, and Palantir Technologies in the last month alone point to IBM's technological acumen. 

What's more, investors will likely have to wait for the deal to close before they see any signs of improvement. In 2020, IBM's total revenue was down 5 percent from a year ago, resulting in a 41 percent drop in net income.

Amid the revenue decline, sales, general and administrative expenses rose 12%, while other income of nearly $968 million in 2019, fueled by asset sales and a one-time gain in the same year, became an expense of $861 million in 2020.

Besides, largely due to the decline that followed the January earnings report, IBM stock has fallen 9 percent over the past year. 

Nevertheless, IBM is paying investors' expectations well. The annual payout of $6.52 per share yields 5.4% cash earnings at current prices, more than three times the 1.5% return on average for S&P 500 stocks. The payout has also increased for 25 consecutive years, making the company the new Dividend Aristocrat.

On top of that, IBM can keep those dividends and raises necessary to maintain Aristocrat status. The free cash flow of $10.8 billion in 2020 will easily fund the $5.8 billion dividend expense for that year. Although the company has a staggering $61.5 billion in debt, it managed to cover $1.3 billion in interest payments in 2020. IBM has also paid down $11 billion in debt since buying Red Hat in July 2019, indicating that the company has strengthened its financial balance sheet during that time.

As with the dividend, a lot could happen to the company over the next five years. However, with NewCo, the infrastructure business will no longer weigh on IBM's finances. Moreover, with double-digit CAGR projected for the cloud industry, IBM seems likely to be able to carve out its hybrid niche in cloud computing and maintain its Dividend Aristocrat status.

Nevertheless, the company's success will likely depend on Red Hat's continued growth and either revitalization or spin-off of less efficient divisions. This expansion is likely to contribute to IBM becoming one of the leading cloud companies and remaining a smaller cloud player.

 While the price is above 114.20, follow the recommendations below:

• Time frame: D1
• Recommendation: long position
• Entry point: 121.93
• Take Profit 1: 130.80
• Take Profit 2: 135.30

Alternative scenario:

If the level 114.20 is broken-down, follow the recommendations below:

• Time frame: D1
• Recommendation: short position
• Entry point: 114.20
• Take Profit 1: 106.90
• Take Profit 2: 1102.60